by Fixed capital requirements: In order to start the business, funds are required to purchase fixed assets like land and building, plant and machinery, and furniture and fixtures. This is known as fixed capital requirements of the enterprise. The funds required in fixed assets remain invested in the business for a long period of time.
Different business units need a varying amount of fixed capital depending on various factors such as the nature of the business, etc. A trading concern, for example, may require a small amount of fixed capital as compared to a manufacturing concern. Likewise, the need for fixed capital investment would be greater for a large enterprise, as compared to that of a small enterprise.
Fixed capital involves allocation of firm’s capital to long-term assets or projects. Managing fixed capital is related to the investment decision and it is also called Capital Budgeting. The capital budgeting decision affects the growth and profitability of the company.
Factors Affecting Requirement of Fixed Capital:
- Nature of Business
- Scale of Operation
- Technique of Production
- Technology Up-gradation
- Growth Prospects
- Availability of Finance and Leasing Facility
- Level of Collaboration/Joint Ventures
Working Capital
The quantum of working capital is depending upon a large number of factors. It is very difficult to pin point the factor which is highly responsible. The degree of influence of each factor varies from time to time. However, the following are considered some of the important factors that generally influence requirement for working capital.
Factors determining working capital requirements
- Nature of business determines working capital requirement
In the case of trading concern, there is a need of maintaining large inventories, receivables and cash. Minimum fixed assets is enough. Hence, the trading concern requires more amount working capital. In the case of service organization, large number of fixed assets are required and the services are rendered only on cash basis.
Credit is allowed only to some extent and short period. Hence, the service organization requires less amount of working capital. In the case of manufacturing concern, sizable amount of working capital is required along with large number of fixed assets as in the form of investment.
In nutshell, trading concern requires more working capital and service organization requires less working capital whereas manufacturing concern requires the working capital between these ends.
- Size of Business / Scale of Operation determines working capital requirement
Generally, more amount of working capital is required if the size of business concern is large and the scale of operation is also high and vice versa. Sometimes, small concerns need more working capital due to high overhead charges and inefficient in use of available resources.
- Production Policy determines working capital requirement
If the production is carried on the basis of order, less amount of working capital is enough. Sometimes, the production is carried on in anticipation of demand in future. If so, more amount of working capital is required. Some products have seasonal demand. In this case, more amount of working capital is required.
- Credit Policy determines working capital requirement
If the company follows liberal credit policy and allows more credit sales with long period for repayment, there is a need of more amount of working capital and vice versa.
- Credit Period Allowed by the Suppliers determines working capital requirement
The credit period allowed by the suppliers may be either short or long. If the credit period is short, there is a need of more amount of working capital and vice versa.
- Manufacturing Process determines working capital requirement
The manufacturing process may be two, three or four. Moreover, the time required in each process may differ from one process to another. If the number of manufacturing process is large and the time required for each process is short or more, there is a need of more amount of working capital.
On the other hand, if the number of manufacturing process is short and the time required in the process is also short, there is a need of less amount of working capital.
- Working Capital Cycle determines working capital requirement
Working capital cycle refers to the time required to convert the raw materials into finished goods and up to the stage of conversion of finished goods into cash form. If the working capital cycle is long, there is a need of more amount of working capital and vice versa.
- Seasonal Variation determines working capital requirement
Some raw materials are available only in season. But, the need of raw material is throughout the year. Hence, the company is forced to buy the raw materials in bulk and store them for one year. If so, more amount of working capital is required.
- Season Business determines working capital requirement
Some products have marketability only in season. In this case, more amount of working capital is required during seasonable period and less amount of working capital is required for off season period.
- Business Cycle determines working capital requirement
Business cycle means periods of prosperity, recession, depression and recovery. Whenever the demand for the product is high, prices of the products are also high during the period of prosperity. Therefore, the company requires more amount of working capital.
On the other hand, if the demand for the product is low, prices of the products are also low during the period of depression. Therefore, the company requires less amount of working capital. During the period of recession and recovery, demand for the product and price of the product are moderate. Therefore, the company requires moderate amount of working capital.
- Rate of Stock Turnover determines working capital requirement
Rate of stock turnover refers to the speed at which the raw materials, work in progress and finished goods converted into cash form. Therefore, if the rate of stock turnover is high, the need of working capital amount is low and vice versa.
- Speed of Growth of the Company determines working capital requirement
The need of amount of working capital is high if the speed of growth of the company is high and vice versa.
- Earning Capacity of the Company determines working capital requirement
Some companies have more earning capacity than others due to better quality of the products, monopoly in market and the like. These companies are able to generate more cash inflows than other companies. Hence, these companies require less amount of working capital than others.
- Dividend Policy determines working capital requirement
The dividend policy of a company influences the requirements of its working capital. If the company prefer to issue bonus shares in the place of cash dividend, the company requires less amount of working capital. In other words, if the company decided to give high rate of cash dividend, whatever be the generation of profits, the company requires more amount of working capital.
- Changes in the Price of the Product determines working capital requirement
If the price of the product is highly fluctuating, the company requires more amount of working capital. If the price of the products is steady, then, the need of working capital is low.
- Volume of Sales determines working capital requirement
The volume of sales and the size of the working capital are directly related to each other. If the volume of sales increases, the company requires more amount of working capital and vice versa.
- Term of Purchases and Sales determines working capital requirement
If a company follows credit purchase and cash sales, the need of amount of working capital is less. On the other hand, if a company follows cash purchase and credit sales, the need of amount of working capital is high. Likewise, a company requires moderate amount of working capital whenever a company follows cash purchase and cash sales and credit purchase and credit sales.
- Expansion of the company determines working capital requirement
If a company has the plan for expansion, such a company requires more amount of working capital. If a company has no plan for expansion, less amount of working capital is enough.
- Operating efficiency of the company determines working capital requirement
This relates to the optimum utilization of resources at a minimum cost. If a company is effectively operated, there is a possibility of controlling of operating costs.
- Profit Appropriation determines working capital requirement
The profits earned by a company is not fully available for working capital purposes. The way profits are appropriated directly affects the contribution towards working capital. If more amount of profits is appropriated, more amount of working capital is available and vice versa.
- Credit Policies of Reserve Bank of India determines working capital requirement
If the Reserve Bank of India follows selective and restrictive credit policies, the company is not a position to get credit facility from its suppliers. In this case, the company requires more amount of working capital.
- Capital Structure of the Company determines working capital requirement
If shareholders have provided some funds towards the working capital needs to some extent, the company can get adequate amount of working capital without any difficulty. If the company has to depend entirely upon outside sources for both permanent and temporary working capital needs, the company faces a lot of difficulties for getting adequate amount of working capital.
- Proportion of the Cost of Raw Materials to Total Costs determines working capital requirement
In those industries where cost of material is a large proportion of the total cost of the goods produced or where costly raw materials are used, large amount of working capital is required. If the proportion of raw materials is small, the amount of working capital requirements is also low.
- Other Factors determining working capital requirement
Some other factors are also affect the requirements of amount of working capital. They are management ability, involvement of employees, import policy, asset structure, utilization of resources, importance of labour, banking facilities and the like.
